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Central America and the Dominican Republic: Evaluating the First Years of Implementation of the DR-CAFTA

After its implementation began in 2005, the Central America – Dominican Republic Free Trade Agreement (DR-CAFTA) has generated important economic gains for the region. It has thus helped sustain a regional consensus on the importance of regional integration and has provided the pragmatic and flexible means through which integration is moving forward. In April 2010, the Latin American Program, together with the Central American Bank for Economic Integration (CABEI), assembled a large group of regional and foreign experts in Tegucigalpa, including specialists from all international organizations currently accompanying and advising the DR-CAFTA process in Central America, to examine the evolution of the agreement and how it has transformed the economic, political, and social environment in the region.

Experts agreed that DR-CAFTA has been an important driver of Central American integration, as it brings together Central America, the Dominican Republic, and the region's largest trading and investment partner. Contrary to popular perception, the agreement's largest impact has not been in reducing Central American tariffs, but rather in guaranteeing preferential access to the United States for the region's exports, fostering business climate reforms (such as intellectual property laws, liberalization of key sectors like telecommunications and insurance in Costa Rica), and providing access to government procurement. As the global economic crisis affected U.S. trade patterns, regional markets became an important resource for Central American exporters, thus giving new impetus to the region's internal agenda. This, in turn, benefitted from the coordination mechanisms and policy changes undertaken in the context of CAFTA. Yet experts cautioned that progress in Central American regional integration has been uneven. For example, while Nicaragua has pursued production policies with strong regional incentives, Costa Rica has offered fiscal stimulus to its duty-free production zones in spite of regional production integration efforts.

Most experts and officials agreed that DR-CAFTA is not the end but rather the beginning of a process of economic development and competitiveness for Central America and the Dominican Republic. In spite of visible gains in export volumes and foreign investment, various reforms are still pending if the region is to take full advantage of the instruments and opportunities available as a result of the accord. For instance, countries have done too little to diversify production and export markets. Regional coordination of certain policy instruments and efforts to strengthen compatibility of DR-CAFTA with Central America's ongoing integration process, though improved, are moving slowly. Foreign investment is encountering certain hurdles in the region, including logistics bottlenecks, regulatory complexity, and Central America's escalating security problems. These matters, especially security, demand regional solutions.

Labor issues also pose challenges for the DR-CAFTA countries. Although the DR-CAFTA has created an additional legal obligation for countries to implement their own labor laws – an important achievement in and of itself - the agreement is not much help in addressing many of Central America's most important labor issues. For instance, more than half of the region's workers belong to the informal sector, thus remaining largely outside the realm of existing labor legislation. For this and other reasons, many analysts believe the labor issue is closely linked to Central America's democratic development, especially formal employment that can provide better opportunities for workers.

Progress in environmental issues remains a pending agenda. The DR-CAFTA introduced a variety of mechanisms to enhance environmental monitoring; it even opened the possibility of a payment mechanism to address environmental services in the region. However, Central American governments have not taken advantage of this opportunity. Moreover, as in the question of regional integration, legislative advances in environmental compliance have been uneven. For example, Nicaragua and Honduras are the only countries that have approved laws on the crucial issue of water usage.

Finally, even though DR-CAFTA has been an important boost for financial integration in the region, Central America is still vulnerable to financial and fiscal crises and should deepen reforms in these areas. Central America's generally low tax base is a symptom, among other things, of scant macroeconomic policy coordination among governments. Even though DR-CAFTA has fostered the regional presence of private financial institutions, increased competition, and an improvement in perceptions of financial risk, regulatory strengthening and a region-wide system of financial supervision based on risk are pending reforms.

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